See Annex A for a more detailed description of the items listed above.

Need to Align Qualitative and Quantitative Functions Within the Family Office

With increased sophistication of family office investment programs and operations, family offices are becoming more institutionalized and adopting best practices.

While family offices are moving toward greater institutionalization and emphasis on quantitative functions (such as investment management and accounting), we are seeing an increased focus on qualitative roles (such as education, governance and family mission/values).

It is important for family offices to align and balance those quantitative and qualitative functions to drive and reward behaviors by the family office team that further those goals.

Non-Financial Goals That Families Should Consider in Gauging Whether Their Family Office is Being Successfully Managed

Developing/delivering a high-quality business plan and cash flow budget annually

Developing/executing a sound investment program responsive to current conditions, supported by effective processes

Developing/maintaining a strong investment team of employees, consultants and third party firms focused on managing the family’s assets and supporting a positive and collaborative culture

While vast majority of family offices pay bonuses to the top executives (management and investment teams), discretionary bonuses still favored approach, but trend toward increased use of Long-Term Incentive (LTI) plans with objective performance milestones

Written employment agreements more common now, but still not universally used (best practice is to document compensation arrangements and restrictive covenants)

Phantom equity still more prevalent than direct equity in family-owned operating companies and the family office investment vehicles

Increased use of vesting for phantom equity and direct equity participation to promote retention (3-5 years most common)

Increased use of restrictive covenants:

Non-Disclosure Agreements to protect family financial/investment information, personal data and other confidential family information

Non-Solicitation restrictions on hiring of family office personnel

Non-Competes are less common due to nature of the family office’s activities and lack of outside clients

Increased use of industry data/surveys/consultants to better benchmark compensation structures and packages to ensure competitive with industry and adoption of best practice in order to attract and retain top talent

Structuring Family Office Co-Investment Vehicles to Permit Friends to Co-Invest in Deals Without Jeopardizing the Family Office Exclusion From Registration

Coordinate and manage work of external advisors and corporate service providers

Risk Management/Liability Management

Perform general and focused risk management

Organize and manage periodic evaluation of liabilities and risks

Education, Family Continuity; Mission Statements; Family Charters

Identify and help access various informational and educational opportunities for the family and other individuals to further professional and personal growth (both within and outside of the family office/business)

Background: Day Pitney is currently working with a single family office client now who has made a fairly significant direct investment in cryptocurrency/digital assets and wants to have two close friends that are knowledgeable about the crypto space (and who brought the investment to the family), but are not “family clients” (i.e., neither family nor key employees), participate in the investment along with the family. The client wanted to ensure that doing so did not violate the family office rule that requires that the family office only advise “family clients.”

“Family Office Rule” Analysis: In this particular situation, the family office was neither recommending this investment to the non-family client investors nor charging them any fees (in part because they brought the deal to the family but also due to a long and close relationship). Since the family office was not charging any fees (including no promote or profit split) and was not recommending the investment to the non-family clients, having them participate along with the family together in a single investment vehicle should not be deemed to violate the family office rule.

Investment Structure: We structured a Delaware LLC and had separate classes of units for the family members, key employees and the non-family clients. The family gave the non-family clients a “profits interest” in the LLC in recognition of the value provided by bringing the investment opportunity to the family. The profits interest is tax-efficient for the recipient and was subject to a vesting period. The profits interest was in addition to the capital interests issued to all members, including the non-family clients for each member’s respective cash capital contributions. Governance of the investment vehicle was ultimately controlled by the family office.

Loans to Key Employees: The family office provided a loan to two key members that matched the amount of cash put up by the key employees (CIO and COO) to boost the amount of their investment. The loans were at 3% interest (interest and principal to be deferred until maturity) and were secured by half of the equity purchased in the LLC (i.e., the amount of the interest purchased with the loan proceeds). The loan balance was required to be paid down with any distributions from the LLC.

Tracking Partnership: We also are working with the client to establish a tracking partnership to create flexibility for family clients and key employees to co-invest together in a single investment vehicle. A tracking partnership allows the partnership to separate its assets into classes or pools, enabling partners to participate in each asset class to varying degrees. For example, a tracking partnership may hold securities (Class A), commodities (Class B), and alternative investments (Class C). Some partners may want heavy exposure to Class C, while others are more risk averse. A tracking partnership allows each partner to have a fixed partnership “percentage interest” while holding varying percentages of each asset class. The partnership is treated as a single entity from both a state law and a federal tax perspective. The tracking partnership allows families to then decide how they want to allow key employees and/or family members to participate in some or all of the investments made by the tracking partnership and to vary the sharing ratios of each depending on a variety of factors (e.g., origination, finding co-investors, lenders and exit partners).

This communication is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This communication may be deemed advertising under applicable state laws. Prior results do not guarantee a similar outcome.

Warren Whitaker will be serving as chair of the 15th Annual International Estate Planning Institute, hosted by the New York State Bar Association and The Society of Trust and Estate Practitioners USA (STEP USA).

At the Family Office Association's Miami Retreat on January 29, Scott Beach moderated a session with Brian Batson, a partner with Krupin Partners, a firm based in Beverly Hills that specializes in insurance solutions for high-net-worth individuals and family office principals/executives.

On January 16, Carl Merino and Warren Whitaker participated in "Estate Planning Across Borders: A Guide for the Perplexed," a program at the annual meeting of the New York State Bar Association presented by the Trusts and Estates Law Section.

January 16, 2019

Trusts and Estates Law Section, New York State Bar Association, New York, NY